Regulations on ETFs

ETFs combine several stocks into one security similar to a mutual fund.

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An exchange-traded fund invests in multiple securities and sells shares of the proceeds. ETFs offer the easy trading of a stock along with the diversification and investment management benefits of a mutual fund. They are sold in large blocks of shares known as creation units. The creation units are frequently purchased by institutions that split the block and sell individual shares to private investors on secondary markets. To purchase or redeem ETFs directly from the issuing company, you must exchange a mix of securities that match the fund's portfolio.


The issuing company must petition for an exemption from the regulations of the Investment Company Act of 1940 because ETFs do not fit the traditional definition of a closed-end fund or mutual fund under the act. The issuer must claim it has a need to issue shares that may only be redeemed in large blocks to establish the fund's creation units, request permission to allow investment companies to purchase ETF shares over the amounts listed in the act, or request permission for in-kind purchases and redemptions of creation units.


Each ETFs must file a prospectus with the SEC before listing the fund on the open market. It must provide a copy of the prospectus to all investors holding at least one share of the fund. It may send a summary prospectus to save on postage expenses, but it must also publish the full document on its website. A printed copy must be available by request at no charge to the shareholder.

Domestic ETFs

The index of a domestic ETF must include at least 13 different securities. The most heavily weighted security in the index may not exceed 30 percent of the fund's total portfolio. The value of the five most heavily weighted securities may not exceed 65 percent of the portfolio. Ninety percent of the fund's stock holdings must have a total trading volume of at least 250,000 shares and a minimum value of $75 million.

Fixed-Income ETFs

Fixed-income ETFs may contain only fixed-income securities. Convertible securities are allowed until they are converted into a variable income security. The most heavily weighted security may not represent more than 30 percent of the fund's entire portfolio. The five most heavily weighted securities may not exceed 65 percent of the total portfolio. Seventy-five percent of the fund's portfolio must have a minimum outstanding original principal of $100 million.

Global Equity ETFs

To qualify as a valid global equity ETF, the fund must contain at least 20 foreign investments. Ninety percent of the total stock must have a value of $75 million and a trading volume of at least 250,000 shares. The most heavily weighted security must form no more than 25 percent of the total of all holdings. The five most heavily weighted securities may not exceed 60 percent of the total.